Eliminating Payroll Tax Is Key To Job And Economic Growth

Law360 (March 24, 2020, 8:56 PM EDT) --
William Drayton
William Drayton
It’s remarkable how the debate on what to do about coronavirus’ damage to the economy is largely a debate on what to do about payroll taxes.

Last week the U.S. Chamber of Commerce wrote to President Donald Trump and members of Congress warning of potentially devastating economic effects from the pandemic and asking for three months’ relief from employers’ portion of payroll taxes.[1]

President Donald Trump’s proposal for a zeroing out payroll taxes for the rest of 2020 as part of pandemic relief hasn’t gotten much traction on Capitol Hill. But he did succeed in getting Senate Republicans to include a long deferment for the employer side of payroll taxes in their proposed package,[2] all the way to 2022 — effectively the payroll tax holiday the chamber requested.

Senators David Purdue, R.-Ga., and Thom Tillis, R-N.C., also introduced an amendment to suspend payroll taxes for employees as well as employers for one year. And the Families First Coronavirus Response Act, signed last week, includes substantial payroll tax relief for small businesses.[3]

Critics point out payroll tax cuts won’t do anything for people who lose their jobs and aren’t on a payroll. Some argue it would overwhelmingly benefit the wealthy and skew toward employers and well-heeled workers.[4] Accepting that argument, Democrats excluded payroll tax cuts from their relief packages.

Instead, Sen. Chuck Schumer, D-N.Y., proposed expanding unemployment benefits and paid medical leave to cover all workers affected by the pandemic, and Sen. Bernie Sanders, I-Vt., proposed a temporary expansion of Medicare to cover all coronavirus-related expenses for all Americans. But these are expensive propositions, even for three or six months, and they’re funded by payroll taxes.

Who’s right? Should we eliminate payroll taxes to head off devastating consequences, or redouble demands on the revenue payroll taxes bring in with big spending programs?

Both sides make valid points, but there’s a strong, underappreciated case for cutting payroll taxes to recover from coronavirus shock — and to ensure higher growth long-term.

Payroll taxes raise hiring costs, suppress labor demand and undercut job growth. They also shrink paychecks, suppress consumer spending and undercut economic growth.

During the last economic crisis and the debate over a massive relief package, the Congressional Budget Office found that cutting them would do more to create jobs than any other intervention (including infrastructure spending). So although they won’t immediately help people who are out of work, they’ll do more than any other measure to create new jobs and put them back to work. If done right (admittedly a big “if”), payroll tax cuts would overwhelmingly benefit working families and the unemployed.

Currently payroll taxes are used as a kind of crazy cash cow. Their impacts are perverse, but we’re addicted to the revenue. Payroll taxes have grown from 1% to 2% of federal revenue when FDR instituted them to 35% today, and their income cap keeps rising each year. Raising payroll taxes is still the go-to funding mechanism for big spending programs like paid family leave, Medicare for All and the Green New Deal.

But payroll taxes come with big liabilities: taking money out of workers’ paychecks, disincentivizing hiring and cannibalizing job growth. We can’t make the economy resilient, fix massive hidden unemployment, or make Americans economically secure without weaning ourselves off them.

On the other hand, how can we wean ourselves off the source of 35% of the federal revenue — $1.3 trillion a year — without causing new, untenable fiscal problems that could hit people and the economy hard? We need revenue to cope with crises like the one we’re in now. If payroll taxes are cut or deferred, when we need new federal spending, we’ll either have to make draconian spending cuts elsewhere as Trump wanted, go yet deeper into debt, or both.

This fundamental dilemma — whether to cut payroll taxes to create jobs or redouble reliance on their revenue to expand the safety net — long predates the coronavirus. But the pandemic and its tangible threat of mass unemployment makes it more salient, so the question of what to do about it has shot up the policy agenda.

When Secretary of the U.S. Department of the Treasury Steven Mnuchin warned unemployment could rise to 20% and throw 32 million Americans out of work unless the government intervened, he wasn’t grandstanding.[5]

No one knows how long the pandemic will last or how many people could lose their jobs — 32 million is as good a guess as any. The CEO of the Federal Reserve Bank of St. Louis thinks it could hit 30% or 48 million.[6]

But neither of them pointed out that before this crisis hit, the labor market had long been suffering from hidden, unofficial unemployment more than twice as bad as the job losses they now fear.

For many years now, due to historically low labor-force participation, over 100 million working-age Americans have been without jobs. Some of them retired early, some don’t work by choice and some aren’t physically able to work. But it’s safe to say that the majority would choose to work given reasonable job opportunities, which they lack.

Of the 159 million Americans who do work, 22 million are part-time or seasonal workers,[7] some by choice, most not. Many millions of them would likely choose to work more if they had the opportunity, but they don’t.

These startling facts have been hiding in plain sight in monthly U.S. Bureau of Labor Statistics jobs reports, even the rosy ones. The February report with a low official unemployment rate of 3.5% didn’t reflect the coronavirus' impact, and subsequent reports will look very different.

But even the February report clearly shows that of 260 million American adults, 95 million are defined out of the workforce, and a total of over 100 million don’t work.[8] This has long been the case, but now it’s about to get much worse.

Meanwhile, we’re running trillion-dollar deficits. Even before the crisis hit and Washington started taking drastic countermeasures, U.S. government debt was already higher than it had ever been,[9] and interest rates were already near their historic lows.[10] That left us on precarious footing when the pandemic arrived.

Last week, the Congressional Budget Office released its updated budget projections, which predicted debt would be about equal to gross domestic product by 2030 — and that’s without taking the pandemic into account.[11] With borrowing and interest rates already so leveraged, policymakers have fewer tools available to mitigate the pandemic's shock to jobs and growth.

The Federal Reserve has a dual mandate “to foster economic conditions that achieve both stable prices and maximum sustainable employment.”[12] We tend to forget about the employment part of its mission, but it’s arguably the more important part, since stabilizing prices isn’t much help to people with no job and no income.

Monetary policy is a blunt instrument, especially when it comes to stimulating employment. But with the Fed’s latest interest rate cut to near zero, whatever can be done with it has been done. There’s nowhere left for interest rates to go.

Maxing out interest rate cuts leaves direct stimulus spending and tax policy as the two remaining policy levers. Emergency stimulus spending is fast and reassuring in a crisis, but isn’t necessarily the best way to boost the economy. There are also limits to how much we can spend on emergency relief without paying for it, either with new revenue from other sources or spending cuts to other programs.

We’re now testing those limits in unprecedented ways.[13] All told, the emergency packages being negotiated total about $2 trillion and counting[14] — roughly triple the size of past emergency stimulus packages. Will emergency spending amounting to 10% of GDP, financed with yet more debt, actually work to stimulate the economy? Or will running deficits up that high cause more damage than it repairs? It seems we’re about to find out.

One thing is already clear: These giant spending packages won’t do much to create jobs, even if they preserve some existing jobs.The “phase two” $100 billion relief package pays for free COVID-19 testing, food aid, more unemployment and health insurance, and paid medical leave (though only for 20% of workers). Those things are all necessary, but don’t create jobs.

The current GOP proposal includes $500 billion to send most Americans $1200 checks. That will temporarily rescue some distressed households, which is also necessary, but won’t create jobs either. Checks may not even have a big impact on consumer spending and economic growth, since they are one-time (possibly two-time[15]) infusions.

Other proposals would provide longer lasting relief. The relief package passed by the House and Schumer’s proposal in the Senate would vastly expand unemployment insurance, extending eligibility to more people, and paying out full salaries for months.[16]

At present writing, the Senate relief package includes $500 billion in liquidity assistance (mostly loans and guarantees) for companies, states and cities, with earmarks for the airlines and other distressed industries. There's also $350 billion in small business loans.[17]

Those proposals could have knock-on effects for the economy, and the loans in particular could save existing jobs and businesses. But they are unlikely to create new jobs for the tens of millions of Americans who will soon need them.

It’s worth remembering that in the Great Recession, when corporations got big federal bailouts, they invested them heavily in stock buybacks, which don’t help sidelined workers.

Not only are these spending programs not targeted to job creation, they appear to be debt-financed. Trump wanted half of the $8.3 billion relief package passed earlier this month to come from budget cuts elsewhere, but he was overruled — it’s all new money. As far as we know, the bigger spending packages will be too. That means they will further balloon deficits, which could further constrain the economy and undercut job recovery, and/or trigger spending cuts that hurt people who need help, for example cuts to Social Security.

So with the interest-rate pedal already to the floor, and debt-financed federal spending reaching its upper limits, what about the other remaining lever: tax policy?

Trump had floated a payroll tax cut, including for employees, as a means of middle-class relief last summer. It failed to get political traction last year, but that doesn’t mean it wouldn’t be an effective stimulus now.

Payroll taxes are the largest tax that 62% of Americans pay, and the most regressive, so cutting them brings working families the most relief. As the American Enterprise Institute’s James Pethokoukis wrote, “If you’re looking to further reduce the tax burden on working-class Americans, the focus should be on payroll taxes.”[18]

Unlike the other measures on the table, cutting payroll taxation is the one policy lever targeted to job creation, since it would lower hiring costs. And unlike the other proposals, which are debt-financed, it could be paid for as we go.

The GOP Senate proposal is to defer large employers’ 2020 payroll tax liability to the end of 2021 and 2022, not to cancel it. That’s more fiscally conservative than the straight payroll tax holiday the Trump administration wanted, but it would still leave a large gap in federal revenue for this year and next — perhaps $300 billion a year.

There is a much better, cleaner way to provide payroll tax relief without blowing a hole in revenues. The key is to cut payroll taxes for both employers and employees, and to make the cuts budget-neutral, paying for them with new revenues from nonlabor sources.

This strategy is known as tax shifting because it doesn’t just cut the taxes, it replaces the revenue from payroll taxes, which undercuts jobs, with revenue from nonlabor sources (chiefly natural-resource taxes), which don’t.

The approach pays for itself. It doesn’t increase deficits or net taxes at all; it simply shifts the tax burden off of employing people and onto consuming material things. It’s effectively a free stimulus, which is something we may find we need, if we must grapple with the consequences of $2 trillion in debt-financed new spending.

Payroll tax shifting can focus well over $2 trillion on stimulating job and economic growth, without costing taxpayers a dime. Here’s how:

Suppose we went even further than Trump wanted to go, and eliminated payroll taxes for workers as well as employers. We could start by extending the payroll tax holiday offered to employers to workers too, and then progressively phase payroll taxation out, until we’d zeroed out the $1.3 trillion in annual revenue payroll taxes bring in.

Next, we would progressively phase in nonlabor taxes and tax expenditure reductions to make up the lost revenue. It could be any combination of taxes at modest rates on nonlabor inputs to business — e.g., a nonlabor value-added tax, a carbon tax, and/or other broad-based taxes on materials, energy, waste, pollution, or land — phased in until we entirely replace payroll tax revenues.

Overall that would be a $2.6 trillion shift from taxing employment, which we need to maximize, to taxing forms of consumption that we would be better off discouraging.

For workers and businesses, there would be a giant price signal shouting “HIRE!” It would shift the relative price of labor versus nonlabor production factors (materials, energy, land, pollution) by 30% (i.e., since the combined employee and employer portions of payroll taxes add up to 17%, and in this scenario revenue from nonlabor sources would ramp up 13%).

Price signals are powerful things. When the price of oil and other commodities went up in the early 1970s and labor prices stagnated, capital flowed quickly and substantially into conserving energy. And that was a relatively small price shift. A 30% price shift between labor versus consumption of materials is gigantic, and could have gigantic results — including an estimated 45 million full-time equivalent jobs.

Why so many? Because such a price shift would reverse longstanding price distortions. Eight decades of payroll taxation has raised labor costs and effectively subsidized natural resource consumption, incentivizing a structural imbalance in the economy that has grown imperceptibly over time — so much so that we aren’t even aware of the hidden unemployment affecting 100 million Americans.

Flipping the relative pricing of employing people versus using things would take the self-imposed brakes off labor demand, so that when the coronavirus abates and the economic activity resurges, we’ll have job creation at the scale we need: tens of millions of new jobs.

Unlike simply cutting or deferring employers’ payroll taxes without replacing the revenue, payroll tax shifting would not skew toward employers or the wealthy. For households and businesses alike, it would raise some consumption costs, for example for energy. But consumer prices would go down by a comparable amount as the cost of the labor content of goods and services declined.

Most households, as well as businesses that choose to hire more, would come out ahead. Against no net cost increase for consumers, disposable income would fuel consumer spending, which drives two-thirds of economic growth, accelerating recovery.

The public would benefit from fast growth, less waste and the huge impact of ending mass joblessness. The environment and climate would benefit from shifting the relative prices and incentives that now drive energy waste and pollution — one of the best environmental conservation measures possible.

The government would benefit too, because dependency costs and even health care costs would shrink (people who work are generally healthier and live longer than those who don’t), and the social ills associated with mass joblessness (crime, fear, demotivated students, etc.) would fall as employment rose. A faster growing, more fully employed, more environmentally sustainable economy will enable government, businesses and families help those who need it.

Even before coronavirus, we needed job creation in the eight-figure range to work through massive hidden unemployment. Now we’ll also need jobs for tens of millions of Americans who could lose theirs in the pandemic.

There is no other proposal that can generate jobs on a scale of tens of millions — not even massive infrastructure spending or a WPA-style government jobs program (assuming we could find money for those). And there is no other policy for stimulating jobs and growth that pays for itself in real time, without increasing deficits or net taxes.

William Drayton is the chief executive officer at Ashoka: Innovators for the Public and chair of Get America Working!.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the organization or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

[1] https://www.rocketminer.com/news/national/business-asks-government-to-act-to-avert-devastating-hit/article_177d4214-d24c-54ad-bc44-702f263a4c62.html.

[2] https://thehill.com/policy/finance/488557-senate-gop-plan-provides-massive-tax-relief-loans-for-business.

[3] https://www.cbs46.com/news/senator-perdue-proposes-payroll-tax-cut-in-coronavirus-stimulus-bill/article_94a90ab6-6d11-11ea-8c40-8b59540652d9.htmlhttps://www.marketwatch.com/story/what-the-family-first-coronavirus-relief-bill-means-for-small-business-owners-and-self-employed-people-2020-03-21.

[4] https://www.cnbc.com/2020/03/18/the-difference-between-a-payroll-tax-cut-and-checks-for-all-americans.html.

[5] https://www.businessinsider.com/mnuchin-us-unemployment-rate-could-rise-without-action-coronavirus-cnn-2020-3.

[6] https://www.bloomberg.com/news/articles/2020-03-22/fed-s-bullard-says-u-s-jobless-rate-may-soar-to-30-in-2q.

[7] https://www.bls.gov/news.release/empsit.t08.htm.

[8] https://www.bls.gov/news.release/empsit.a.htm.

[9] https://www.npr.org/2019/02/13/694199256/u-s-national-debt-hits-22-trillion-a-new-record-thats-predicted-to-fall.

[10] https://www.axios.com/what-record-low-interest-rates-mean-7203b184-b1ad-4d96-96e8-06488da2521a.html; https://tradingeconomics.com/united-states/interest-rate.

[11] https://act.myngp.com/el/hnNpJ3f3OVbt0tzdPCeqprJ8W5kTSZTs4HRdODUmz1c=/Z37wdRmjStWOAz73Gfe9XOJyGj-sJecVai_lA8rY0gM=.

[12] https://www.chicagofed.org/research/dual-mandate/dual-mandate.

[13] https://www.wsj.com/articles/u-s-deficit-set-to-soar-as-government-responds-to-coronavirus-11584568685.

[14] https://www.washingtonpost.com/business/2020/03/18/trump-coronavirus-economic-plan/.

[15] https://www.npr.org/2020/03/19/818253789/congress-awaits-gop-relief-plan-as-first-lawmakers-test-positive-for-coronavirus.

[16] https://thehill.com/homenews/senate/489219-schumer-government-will-pay-four-months-of-full-salary-for-furloughed-workers.

[17] https://www.reuters.com/article/us-health-coronavirus-usa-bill-factbox/factbox-whats-in-the-nearly-2-trillion-us-senate-coronavirus-stimulus-idUSKBN21B37G

[18] https://www.aei.org/economics/these-4-charts-might-change-what-you-think-you-know-about-the-american-economy/.

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